For the five years that British forces camped on the Basra air base, the nearby city that they came to liberate remained a lethal tinderbox. Militias ran rampant; residents cowered. Services were medieval.

But a drive through Basra in mid-2010 reveals an entirely different picture. The despairing sprawl British forces left behind 16 months ago is now heaving with new money. Wide boulevards, once scarred with bomb craters and decades of putrid refuse are now full of new cars and touts hawking trinkets.

Three weeks ago something happened that few in Basra thought they would ever see – the reopening of the city's most recognisable landmark, the giant hotel dubbed the Sheraton, that has stood in ruin since April 2003.

The 250-room hotel – five-star by European standards – has been rebuilt, renamed the Basra International hotel, and redesigned by local architect Waad al-Radhi, who left the city two decades ago.

"This is very complicated and very costly," said Radhi, standing in the foyer of the hotel as work neared completion. "But we decided to make the best for this city."

Asked why he had come back at a time when central Iraq remains lethal and when a government has been unable to emerge from the country's third tilt at a democratic election, seven months ago, Radhi said: "When I have an opportunity to work here, the same standards, the same salary and priviliges which I can take abroad, why not work here. All our Iraqi experience will be back home when you can guarantee them life standards."

Outside the window, motorboats and fishing skips churn through the brown silt of the river. A freighter turned turtle off the city's main dock and bullet-strewn buildings on the foreshore are reminders that this was recently a city at war. But the hordes of garish shopfronts, rampant neon lights and streets teeming with shoppers and revellers also reveal a city that is embracing change. Another new four-star hotel across town is constantly full – mostly with foreign businessmen – and new car dealerships line most main roads.

Nationwide security reports released daily since January constantly demonstrate that southern Iraq has evolved from a war zone to a benign place where weeks often go by without a single shooting, or bombing.

Violence has not stopped completely and more than 50 people were killed during a day of bombings in early August. But the contrast to the rest of Iraq is marked.

"We are flourishing this year," said mobile phone salesman Irfa Abbas Khudier, in front of a row of fake iPhones inside his downtown Basra stall. "Incomes are up, the people are feeling better, the jobless are finding work and many foreign investments have started."

This cruel and desolate city seems to have found a softer edge, where the trappings of the west and even foreigners who come to revel in the spoils are suddenly welcome. Against many expectations, Basra is steadily being transformed into a Mini-Me of the Kurdish city in northern Iraq, Sulaymaniya. There is one common denominator between them – oil and the flush of wealth it has brought.

The first round of oil auctions in Iraq last year cast Basra as potentially the largest beneficiary of the move to lure foreign investors to untap Iraq's vast amounts of underground black gold. But it was a projection that those who had lived through nothing but worst-case scenarios found difficult to believe.

"Visitors come here and say they don't recognise Basra anymore," said Firas Mohammed, who opened a cosmetics centre late last year. "I left for two years from 2006 and I returned to open my business. It is already going very well and will be much better very soon. This was the city of nightmares. Now shops are open until midnight and families are playing in new fun parks."

Throughout the centre of the city, several hundred shops have opened in recent months, selling anything from Turkish shawls, Gulf fragrances and Lebanese sweets. Fun park rides compete for space along riverside parklands that were deserted for most of the past five years. Even the riverboat restaurants are plying a trade of sorts, serving fried food on rusting decks that had been empty since 2004.

The deep south had been persecuted throughout Saddam Hussein's totalitarian regime, during which he viewed the predominantly Shia Muslim population as proxies of his mortal foe, Iran.

Oil pipes, roads, and other services had not been updated since the 1960s. Many Basra suburbs did not have sewage lines. Most had next to no electricity, or hope that things could ever get better.

This hardly dissuaded the global oil giants who flooded into town once the first round of contracts were awarded last August. In their wake came hundreds of smaller outfits on the hunt for service contracts, as well as prospectors and carpet baggers. BP and the Chinese oil giant CNPC are setting up camps at the huge North Rumaila oilfield north of town and Exxon Mobil are digging in in the nearby Majnoun field.

Wedged into the ground 40-70 metres below their feet is around 40% of Iraq's oil, a resource that could eventually transform the economy into one of the world's leading economic powerhouses. "This is potentially the fourth biggest oilfield in the world," said Gary Jones, BP's director of operations in North Rumaila. "The intention is not just to create a spike but to build production to nearly triple capacity."

Immense amounts of infrastructure, drills, turbines and rigs, are being brought on to Rumaila and Jones says the consortium is on track to increase the production of barrels per day by 10%, from 1.045m to roughly 1.2m by the end of the year. The nationwide barrel per day optimum is 2.5m, but Iraq's collective oil output has so far reached only 80% of that.

Jones says that any excess electricity generated by North Rumaila could be sent down the line to Basra city, which is reeling under the effects of a catastrophic under-supply of national grid power that has seen most homes in the centre and south of the country reduced to around four hours of government supplied electricity per day – most of it too weak to run air conditioners to ward off staggering summer heat. Yet from his Baghdad office, oil minister Hussein Shahristani is presiding over one of Iraq's few success stories and he likes what he sees. "I have always had a soft spot for the Shias of the south," said Shahristani, himself a Shia Muslim. "What is happening down there is truly remarkable.

"We know that we cannot start a proper rebuilding programme without the oil sector," he said. "That's why we were so committed to making sure we attracted the oil companies and we are very pleased with the results.

Elsewhere in Iraq, however, the Shia revival is being seen as part of a Persian-led conspiracy that will enrich the Shia south at the expense of the already disenfranchised Sunni centre of Iraq. Development in the rest of Arab Iraq remains paralysed by a political stalemate, which has stirred the ghosts of the sectarianism that tore the country apart not long ago. In Basra, there is little mood to spread the wealth around. "We have had it very tough here for so long and it is now our time to prosper," said the chairman of the Basra provincial council, Jabbar Jaber al-Latif. "I can now say that we are into the first step to change Iraq and especially the south. To turn infrastructure around we will need a long time and a lot of money - but this is a start."

There is still though a fear that the dark days could easily return and that anarchy will never be far away. Iranian influence remains strong, the rule of law feeble and, despite the calm, a belief prevails that the militias that have downed tools are going with the flow for now – not changing their ways for good.